WASHINGTON - Pension liabilities and their associated budget pressures remain significant sources of credit pressure for many states, Standard & Poor's said in a report released Tuesday.
The report - Six Years Into the Recovery, Pensions Are A Big Divider of U.S. State Credit - describes the key pension issues that will help shape public policy debates, budget deliberations, and credit quality this year and in the future.
These issues are: accounting and actuarial changes, the growing gap between well- and poorly-funded pension systems, reform efforts and a renewed interest in pension obligation bonds, according to the rating agency.
Accounting changes are driving changes in pension liabilities, S&P said. The rating agency said it is incorporating new Governmental Accounting Standards Board standards for pension accounting and reporting as its basis for analyzing pension liabilities for states.
"In our view, the new GASB standards have some limitations but make significant improvements to how pension liabilities are calculated, accounted for, and reported in financial statements," S&P said, adding that while some year-over-year comparisons GASB Statements 67 and 68 "may be challenging, we don't expect significant credit differentiation based solely on the new reporting."
The new GASB guidance, among other things, calls for governments to report their net pension liabilities in their financial statements. It also calls for governments to identify their depletion dates - projections of when system assets will be insufficient to fund benefit payments. When such dates are determined, blended rates are used to discount governments' pension liabilities.
S&P said, for example, that New Jersey previously used a 7.9% assumed rate of return on its investments to discount its liabilities. But under the GASB standards, it uses a 7.9% rate of return while assets are available to pay benefits and a 4.29% discount rate after it reaches its depletion date. The blended rate has partly contributed to more than doubling its unfunded liability to $82.77 billion in fiscal 2014 from $37 billion in fiscal 2013, the rating agency said.
The changes in actuarial assumptions, particularly those relating to mortality table updates in October 2014 and generally lower rates of return, have also driven liability growth, S&P said.
In New York, for example, the updated mortality assumptions caused annual contribution rates in the proposed fiscal 2016 budget to increase to 18.2% from 14.2% for the Employee Retirement System and to 24.7% from 20.8% for the Police and Fire Retirement System.
Meanwhile, pension reform "muddles along," S&P said in the report. While reforms have remained "front and center introducing significant budget and financial plan uncertainty" in many states, including Rhode Island, Illinois, New Jersey, Kentucky and Pennsylvania, these efforts have often led to litigation and, even if enacted, could take years if not decades, to be fully implemented, it said.
The combination of higher unfunded liabilities, weak funded ratios for some states, poor contribution histories and low interest rates have increased interest in pension obligation bonds, according to the report.
"While POBs have been a consistent feature of the municipal bond market for the past 25 years, their performance has been uneven," S&P said. "Issuing a POB increases leverage and fixed costs. It essentially creates a fixed debt service obligation in place of a potentially variable annual payment to fund long-term liability."
"It is important to understand the overall financing plan in place, as well as the timing of the POB's issuance, which potentially introduce risk to a state's debt and liability profile from a credit standpoint," the rating agency said.
S&P says it typically examines several issues with regard to such financings, such as how the POBs will affect current contributions, whether any front-loading of savings may lead to higher unsustainable contribution rates, and how the POBs would affect funding goals.
S&P noted that Pennsylvania, for example, has proposed a $3 billion POB issue that would be secured by wine and liquor enterprise profits with increased contributions funded by dedicating the sales tax to a restricted account.
Looking ahead, the report concluded: "It is clear that the issues surrounding public pensions are in a period of transition based on accounting and actuarial changes and funding commitments. As a result, we expect pensions to remain a significant public policy and funding challenge for many state governments and a continuing source of expanding liabilities for most."
